Ever wonder how credit scores are calculated? There are five key components that make up your credit score, and each one accounts for a certain percentage of the overall score. Your credit score moves up and down depending on your use of credit. When reviewing your credit score, keep in mind that it’s not fixed and can change quite a bit from one month to another. Also there are many credit models so the one you see on line isn’t necessarily the one the mortgage company will use. Acheiving a high credit score requires discipline, time and effort. Lets look at the key components:
1. Payment history
Payment history has one of the biggest impacts on your credit score. A single late payment will not automatically tank your score, but if you have a history of late payments it certainly can. How late the payment is will also affect your score, as payments made 60 or 90 days late will be more detrimental than payments made 30 days late.
2. Balances owed
Having high balances on credit accounts doesn’t necessarily make you a high-risk borrower. However, if you have used a large percentage of your available credit, this could indicate you are overextended and more likely to make late payments. When the balance on a credit card exceeds the credit limit it has a large negative impact on the score. Generally they say it is best to have a balance equal to 30% or less of the credit limit. If you can, pay your credit card bills in full each month and you will avoid all finance charges!
Special note on student loans: many people with student loans are either in deferment, forebearance or an income based repayment plan. Interest is accruing and the balance on the student loan(s) are going up. This can hurt your credit score. It is best, at a minimum, to pay the interest every month so that the balance on the student loan does not exceed the original loan amount.
3.Age of your credit
– The amount of time you’ve held credit accounts reflects the length of your experience with the credit system. The longer your credit history, the more information lenders have to determine your behavior and make an accurate assessment of risk.
4. Mix of credit
Your score may vary depending on your mix of credit. The ideal credit report has 3 – 7 open accounts that have are 24 months old or more with no late payments. It’s good to have a mix of loans and credit cards. Having a solid history of paying off /managing multiple accounts can help your score.
5. New credit accounts
New accounts without a history may temporarily lower your score until you establish a history of payment (up to 6 months). Also, often the balance on the new loan is equal to the credit limit which can hurt. When a new account is just opened it may also lower your average account age, which will have an effect on your score as well.